The collective views of forex traders can influence individual price movements and overall market activity, making it a critical factor to trade considerations. Thus, forex market sentiment reflects the mood of the market and helps traders predict the direction of the prices.
- If a majority of forex traders believe that a currency will appreciate, they may tend to buy more, which pushes the prices in an uptrend direction. When prices rise, it represents a bullish market
- If a majority of forex traders believe that a currency will depreciate, they may tend to sell more, which pushes the prices in a downtrend direction. When prices fall, it represents a bearish market
Forex market sentiment is based on collective investor attitudes, which means it can be difficult to predict and analyze. However, traders can use several markers to get a feel of the market sentiment. Fair Forex explains three indicators that traders can use to guide their trading efforts.
Indicator 1: Prices, Momentum, and Volume
Traders don’t have to look far to get a feel of the overall market sentiment — prices, momentum, and volume have stories to tell.
The movement of prices reflects trader response toward a certain pair of currencies.
If the market moves upward quickly but falls slowly, it indicates that the base currency is stronger than the quote currency. Overall, this indicates a bullish market sentiment. If the reverse is observed, the movements show a bearish market sentiment.
Price momentum may indicate who (between bulls and bears) currently exerts greater control of the market. Bulls are optimistic investors who expect prices to rise. Bears are pessimistic investors who expect prices to fall.
- If the currency pair records lower highs when prices are ranging, it may indicate that bulls are losing momentum.
- If the currency pair records higher lows when prices are ranging, it may indicate that the bears are losing momentum.
- If the currency pair makes equal price swings up and down, it may indicate equal strength between bulls and bears.
Trading volume data doesn’t show the direction the market is moving toward, but it does indicate the amount of interest among traders. Lower trading volume may indicate that the interest in a certain currency pair is waning.
In contrast, a higher volume reflects greater interest. Moreover, higher volume usually signifies that the price will begin to move in a certain direction.
Indicator 2: Cboe Volatility Index
Created by the Chicago Board Options Exchange (CBOE), the Cboe Volatility Index is a measure of the volatility of a representative range of options from the S&P 500. Known among traders as the “VIX,” it can help traders interpret market sentiments for currencies and currency pairs that are strongly associated with the S&P 500.
High volatility may signal market pessimism and show that majority of traders are uncertain about the long-term strength of certain currencies. In fact, the VIX is also known as the “fear gauge,” as higher volatility suggests a majority of traders fear a current trend will reverse.
Take the US dollar (USD), the most traded currency in the world, for example. The USD is strongly correlated with the VIX. High volatility in the VIX may demonstrate uncertainty and pessimism towards the strength of the USD.
Indicator 3: NASDAQ Composite Index (VXN)
The NASDAQ Volatility Index (VXN) is similar to the VIX in that it reflects the expectations of price volatility; only this time, it monitors price volatility among NASDAQ 100 stocks, which includes the top 100 U.S. and international non-financial securities by market capitalization.
As an indicator of market sentiment, it gives traders insight into expectations around economic developments and, by extension, NASDAQ market prices, in the next 30 days. Just like the VIX, it indicates the level of uncertainty that traders feel. High volatility may indicate pessimism.
Because about half of the VXN’s composition is technology, the VXN is strongly associated with currencies from economies driven by the technology sector, such as USD and the Japanese Yen (JPY). In fact, USD/JPY tends to trade in the same direction as VXN sentiments.
Traders use a combination of these tools to gauge market sentiment and, by extension, structure their trading strategies. A diligent trader doesn’t rely on one set of many analyses; they look at several metrics at once.
At Fair Forex, professionals are equipped with countless tools to help them determine the best course of action. Additionally, our forex brokerage offers some of the best rates in the market, with one of the lowest commissions and spreads.
Make the most of the forex market with Fair Forex. Contact us today.